Speeches

Economic Outlook for the U.S. & Berks County

Introduction

Since early this year, an economic recovery has been under
way in the United States. For much of this time, interest
has centered on the speed of the recovery. Many economists
--- myself included --- were expecting a modestly paced
recovery, rather than the rapid acceleration of growth that
has been more typical of previous post-war recoveries. Now
the recovery is proving to be even more moderate than we
had expected.

Meanwhile,
the turmoil in financial markets this summer has heightened
everyone's concerns about the recovery's future course.
Professional forecasters are trimming their growth projections
for the year, and people I talk to around the District are
expressing more uncertainty about where the economy is headed.

I too have scaled back my
expectations and share people's concerns about the risks
out there. But I believe the recovery will continue to move
forward. I expect the pace of economic activity to gradually
accelerate through the rest of 2002, setting the stage for
sustained expansion and healthy growth in 2003 and beyond.

Today, I would like to share
my thoughts on how I see the economic recovery unfolding,
as well as the risks we face along the way. I will also
address some issues closer to home, namely the state of
business activity in the Berks County area and the factors
affecting this region's economy.

National Economy

The recent recession has been called a 'business recession'
because it was sharp cutbacks in the business sector that
drove the downturn. I think there is a lot of truth to this
characterization. One implication is that an important driver
of the recovery will be the re-engagement of the business
sector. I see this happening in three stages: first in production,
then in hiring, and finally in investment spending.

Right now I would say we are
mid-way through this process. At the outset of the recession,
firms slashed production in the face of declining sales.
Last year, businesses cleared their shelves of most of their
excess inventories. Since the beginning of this year, they
have been increasing production to meet customer demand.
The Fed's index of manufacturing output has been increasing
since January. Admittedly, last month's increase was very
modest. But with inventories lean, I believe production
will stay on a positive trend.

This brings us to stage two:
hiring. Businesses are no longer slashing payrolls, but
they have not yet begun to hire in earnest. Employment gains
have been positive, but small and uneven over the past several
months. We need to get to the point where firms are consistently
adding over 100 thousand jobs a month in order to see real
improvement in the labor market. In fact, we need more than
that to reduce the unemployment rate. So far firms have
been conservative and reluctant to add to their workforce,
but I expect firms to add to their payrolls once they are
convinced the recovery is sustainable.

The third step in the business
recovery is the resumption of growth in business investment
spending. Here we are at the very earliest stages. That
should not be surprising. All along we had been expecting
businesses would not take this step until their existing
capacity was more fully utilized and their profit pictures
began to improve. There is some evidence that this is happening.
Capacity utilization has been rising, and profits have been
improving. In the second quarter, business spending on new
equipment and software showed its first increase after six
consecutive quarters of sharp decline. I expect an acceleration
in investment spending as we move toward the end of the
year and the recovery progresses.

So at this point, we are in
the midst of the 'business recovery,' but we still have
some distance to go. The fuel that we need to carry this
process forward is business confidence. For businesses to
step up production, hire more workers, and invest in new
plants, equipment, and software, they must be confident
that the economy is coming back and the demand for their
products will continue to grow. In large measure, that means
they must be confident that the consumer will continue to
spend.

Consumer spending has been
remarkably strong throughout this cycle. Its growth slowed
from the frantic pace of the late 1990s. Yet, in spite of
everything  the stock market declines in 2000 and 2001,
the job losses, and even the shock of September 11  we
never saw a negative quarter. In fact, sales of houses and
cars have stayed very strong, buoyed by historically low
mortgage rates and zero percent financing incentives from
auto dealers.

The resilience of consumer
spending made the recent recession one of the mildest on
record. However, this also led us to expect that the current
recovery would be a relatively mild one as well. Because
consumer spending stayed so strong throughout the recession,
we did not expect the usual bounce back when recovery got
under way. Pent-up demand was just not there. And that is
fine, so long as consumer spending continues to grow at
a modest pace to support the business recovery.

But, now, some uncertainty
surrounds the forecast for the consumer. We do not know
whether this summer's stock market decline will induce the
household sector to pull back. I do not think it will. At
least as of July, the stock market retreat had not induced
the consumer to leave the mall. As it is often said, 'Don't
underestimate the consumer's willingness to spend.' I expect
consumer spending to continue growing, but this is a risk
factor in all our forecasts.

One reason that the stock
market's decline may have only a mild effect on the consumer
is that the decline in financial assets has been offset
by appreciation in home equity. A second and more important
reason is whatever is happening to consumers' wealth position,
their real disposable income continues to grow at a healthy
pace. Traditionally this has proved to be a more reliable
driver of consumer spending. Low inflation, low mortgage
interest rates, and lower federal tax rates have combined
to give people more purchasing power.

So, I expect consumer spending
to continue growing and supporting recovery on the business
side. Of course, the business recovery itself will, in turn,
bolster employment, disposable income, and consumer spending.
Indeed, it is that interaction between consumers and businesses
that turns a recovery into a healthy, self-sustaining economic
expansion.

I do recognize that this summer's
developments in the stock market have taken their toll on
people's portfolios, businesses' capacity to raise capital,
and everyone's confidence. However, it now appears stock
markets are beginning to stabilize, and barring further
sharp declines, I expect the recovery to continue, though
perhaps at a slower pace than we were expecting only a few
months ago.

Recently our attention and
concern has been focused on stock prices and the corporate
sector. That is understandable. But several other factors
are shaping the pattern of the economic recovery too, and
I think they bear watching.

One is the likely slowdown
in government spending. At the federal level, the surge
associated with the response to September 11 and the initial
phase of the war on terrorism is dissipating. At the state
and local levels, balanced budget requirements and declining
tax revenues are squeezing governments on the expenditure
side. Here in Pennsylvania, the Commonwealth has been forced
to dip into its 'rainy day' fund to help maintain its programs.
So, looking ahead, the contribution of government spending
to overall demand growth is more likely to shrink than to
swell.

Beyond our own shores, developments
in the global economy are creating some uncertainties for
the U.S. outlook. On a positive note, the economic picture
in Asia seems to be improving. On the downside, the pace
of growth in Europe has slowed, and several Latin American
economies face steep challenges. There are crosscurrents
on the financial side as well. Much as in the U.S., equity
markets around the world have fallen off, diminishing people's
wealth and so potentially slowing economic growth. On the
other hand, the modest decline in the value of the dollar
vis a vis other currencies should help buoy demand for U.S.
exports.

These factors are all worth
watching, but none appear to be of a magnitude to threaten
the recovery. But we should all remember that there are
always risks and uncertainties in the near-term outlook
and every economic recovery is subject to fits and starts.
This one is no exception.

Nonetheless, there is one
persistent positive for the economic outlook that I want
to emphasize. The relatively rapid growth in productivity
that was part of the late 1990s has weathered the recession
well. This is likely to remain intact as we move into the
expansion.

If we look past the boom and
bust in the tech sector, the fact is that the application
of new computing and telecommunications technologies has
already given businesses plenty of new opportunities to
increase efficiency and bolster productivity. And these
technologies continue to get less expensive and more powerful.
As the economy recovers, prospective productivity gains
will provide a strong incentive for businesses to increase
their investments in new technologies.

At the aggregate level, I
expect the continued diffusion of new technologies through
the economy to keep labor productivity growing at an annual
rate of 2 to 3 percent on a sustained basis. Demographics
say the labor force will grow 1 percent per year. If we
combine these two factors, the economy has the capacity
to grow 3 to 4 percent per year on a sustained basis. With
continued strong growth in productivity, our economy can
sustain a higher rate of real growth than most of us would
have thought possible a few years ago.

So my outlook for the national
economy is cautiously optimistic. The recovery continues
to move forward, and our long-run growth prospects are good.
Still, the recovery is more modestly paced than we had hoped,
and it is still subject to more risks than we would like.

In this context, I believe
the Fed's current monetary policy stance is appropriately
supportive of the recovery process. At some point, prudence
will dictate that we begin moving monetary policy back toward
a more neutral stance. But in the near term, given the uncertainties
surrounding the economic outlook, the proper pace and pattern
of future monetary policy actions are difficult to predict.
We at the Fed will continue to watch economic developments
closely and set a monetary policy that we believe will assure
self-sustaining growth.

The Berks County Economy

Let me turn from the national scene to developments closer
to home. As you probably know, the Federal Reserve Bank
of Philadelphia serves eastern Pennsylvania, south Jersey,
and the state of Delaware. Berks County lies roughly at
the geographic center of our District.

One of the key activities
in Reserve Banks is the monitoring of economic developments
in their Districts. I can report that our District economy
has moved through this cycle very much in sync with the
nation. Job losses here have been proportional to job losses
nationally, while unemployment rates in our region have
been just below the national average. Here in Berks County,
unemployment stands at 5.8 percent, compared to 5.9 percent
nationally.

Unfortunately, the close parallel
between the performance of the nation and the region extends
to the manufacturing sector as well. While the recent recession
was generally mild, it hit the manufacturing sector hard.
This has been of particular concern here in Berks County
where manufacturing represents such a significant share
of employment and where layoffs in the sector continue.

As I mentioned a few moments
ago, national manufacturing output began to recover early
this year, but employment in the manufacturing sector has
yet to come back. Our Bank's most recent Business
Outlook Survey, a survey of District manufacturers,
which is a recognized indicator of national trends, tells
the story. It moved into positive territory early this year
and has faltered recently, suggesting that the recovery
in manufacturing activity may proceed in fits and starts.
The data there suggest that gains in manufacturing employment
may yet be some months away.

In Berks County, the manufacturing
core is strong, and longer term, I believe it will remain
strong, because you are taking advantage of the new technologies
that will keep you competitive. I saw that for myself a
few months ago when I was in the area and I had the opportunity
to visit the foundry of a precision metals firm. The company
has been in business since the 1960s. From the outside,
you might be led to believe it had gone unchanged for 40
years. But inside is a different story. In the back of the
facility, where metals are poured, the plant manager showed
me how technology has changed the production process. Everything
from mixing alloy ingredients to testing the final product
is managed from the keyboard of a computer. Production is
more efficient and the product of a higher quality than
ever before.

Like the nation, our District
is evolving toward a more service-based, and hence less
cyclical, economy. That trend is also playing out here in
Berks County. Reading has been growing and diversifying
into the financial services sector. To attract more tourists
and visitors, the region is building on its reputation as
a destination for outlet shopping by adding a new sports
arena and renovating the Lincoln Plaza hotel and the Convention
Center. And as a former finance professor, I cannot resist
emphasizing the benefits of portfolio diversification. One
measure of Berks County's economic diversification is that
no single company here employs more than 2 percent of the
area's workforce.

Having emphasized ways in
which Berks County is evolving in line with national and
regional economic trends, I'll also point out two uniquely
positive features of the region.

The first feature is the relatively
rapid growth in Berks County's population and employment.
Pennsylvania is a notoriously slow growing state, but the
Reading area is just the opposite. Over the past decade,
Pennsylvania's population has grown just 3.4 percent. Meanwhile,
Reading's population and employment have grown 11 percent.

There is no denying that population
growth has brought its challenges to the region. But ultimately
a growing population is a good thing for the local economy.
It brings opportunity for economic growth and change.

A second factor that bodes
well for your future is Reading's unique geographic position
in the midst of the very populous Northeast Corridor. As
modes of transportation have changed, Reading has continued
to be an important node in the transportation network. Early
on, Reading was at the crossroads of a canal network; then
it formed the hub of the Reading Railroad; now it is at
the epicenter of the highway network.

Conclusion

In closing, our District economy continues to evolve in
parallel with the nation's, and Berks County is uniquely
positioned to take advantage of that evolution. The prospects
for the Berks County region are positive as you enhance
traditional strengths and develop new capabilities. The
challenge for you, as business leaders, is to confidently
continue to compete, innovate, and seize good opportunities.
I am sure you will.